Corporate debt financing and earnings quality

Aloke Ghosh, Doocheol Moon

Research output: Contribution to journalArticle

28 Citations (Scopus)

Abstract

Our study establishes linkages between two extensively researched areas, debt financing and the quality of earnings. Debt can have a 'positive influence'on earnings quality because managers are likely to use their accounting discretion to provide private information about the firms' future prospects to lower financing costs. For high debt, it can also have a 'negative influence' on earnings quality as managers use accruals aggressively to manage earnings to avoid covenant violations. Using accruals quality as a proxy for earnings quality, we document a non-monotonic (curvilinear) relation between debt and earnings quality. The relationship is positive at low levels of debt and negative at high debt levels with an inflection point around 41%. Our results suggest that firms that rely heavily on debt financing might be willing to bear higher costs of borrowing from lower earnings quality because the benefits from avoiding potential debt covenant violations exceed the higher borrowing costs.

Original languageEnglish
Pages (from-to)538-559
Number of pages22
JournalJournal of Business Finance and Accounting
Volume37
Issue number5-6
DOIs
Publication statusPublished - 2010 Jun 1

Fingerprint

Corporate debt
Earnings quality
Debt
Debt financing
Costs
Managers
Borrowing
Violations
Linkage
Accruals
Covenant
Debt covenants
Private information
Accounting discretion
Accruals quality
Financing

All Science Journal Classification (ASJC) codes

  • Accounting
  • Business, Management and Accounting (miscellaneous)
  • Finance

Cite this

@article{9d84bd534ad04a3794eb2906f1fa425b,
title = "Corporate debt financing and earnings quality",
abstract = "Our study establishes linkages between two extensively researched areas, debt financing and the quality of earnings. Debt can have a 'positive influence'on earnings quality because managers are likely to use their accounting discretion to provide private information about the firms' future prospects to lower financing costs. For high debt, it can also have a 'negative influence' on earnings quality as managers use accruals aggressively to manage earnings to avoid covenant violations. Using accruals quality as a proxy for earnings quality, we document a non-monotonic (curvilinear) relation between debt and earnings quality. The relationship is positive at low levels of debt and negative at high debt levels with an inflection point around 41{\%}. Our results suggest that firms that rely heavily on debt financing might be willing to bear higher costs of borrowing from lower earnings quality because the benefits from avoiding potential debt covenant violations exceed the higher borrowing costs.",
author = "Aloke Ghosh and Doocheol Moon",
year = "2010",
month = "6",
day = "1",
doi = "10.1111/j.1468-5957.2010.02194.x",
language = "English",
volume = "37",
pages = "538--559",
journal = "Journal of Business Finance and Accounting",
issn = "0306-686X",
publisher = "Wiley-Blackwell",
number = "5-6",

}

Corporate debt financing and earnings quality. / Ghosh, Aloke; Moon, Doocheol.

In: Journal of Business Finance and Accounting, Vol. 37, No. 5-6, 01.06.2010, p. 538-559.

Research output: Contribution to journalArticle

TY - JOUR

T1 - Corporate debt financing and earnings quality

AU - Ghosh, Aloke

AU - Moon, Doocheol

PY - 2010/6/1

Y1 - 2010/6/1

N2 - Our study establishes linkages between two extensively researched areas, debt financing and the quality of earnings. Debt can have a 'positive influence'on earnings quality because managers are likely to use their accounting discretion to provide private information about the firms' future prospects to lower financing costs. For high debt, it can also have a 'negative influence' on earnings quality as managers use accruals aggressively to manage earnings to avoid covenant violations. Using accruals quality as a proxy for earnings quality, we document a non-monotonic (curvilinear) relation between debt and earnings quality. The relationship is positive at low levels of debt and negative at high debt levels with an inflection point around 41%. Our results suggest that firms that rely heavily on debt financing might be willing to bear higher costs of borrowing from lower earnings quality because the benefits from avoiding potential debt covenant violations exceed the higher borrowing costs.

AB - Our study establishes linkages between two extensively researched areas, debt financing and the quality of earnings. Debt can have a 'positive influence'on earnings quality because managers are likely to use their accounting discretion to provide private information about the firms' future prospects to lower financing costs. For high debt, it can also have a 'negative influence' on earnings quality as managers use accruals aggressively to manage earnings to avoid covenant violations. Using accruals quality as a proxy for earnings quality, we document a non-monotonic (curvilinear) relation between debt and earnings quality. The relationship is positive at low levels of debt and negative at high debt levels with an inflection point around 41%. Our results suggest that firms that rely heavily on debt financing might be willing to bear higher costs of borrowing from lower earnings quality because the benefits from avoiding potential debt covenant violations exceed the higher borrowing costs.

UR - http://www.scopus.com/inward/record.url?scp=77955389385&partnerID=8YFLogxK

UR - http://www.scopus.com/inward/citedby.url?scp=77955389385&partnerID=8YFLogxK

U2 - 10.1111/j.1468-5957.2010.02194.x

DO - 10.1111/j.1468-5957.2010.02194.x

M3 - Article

VL - 37

SP - 538

EP - 559

JO - Journal of Business Finance and Accounting

JF - Journal of Business Finance and Accounting

SN - 0306-686X

IS - 5-6

ER -